Issues in Tax Audit under Section 44AB

No government in anywhere in this world has placed so much trust and confidence in Public Accountants like the Indian Government has placed on Chartered Accountants. Tax Audit by a Chartered Accountant is an Indian phenomenon and does not exist in any other country. Finance Act, 1984 introduced Tax Audit under Section 44AB with effect from the assessment year 1985-86. This not only broadened the area of practice by a Chartered Accountant to an unimaginable scale but also pinned so much trust on the Chartered Accountancy Profession. If you say that you are a Chartered Accountant to any stranger, he would say “ Oh ! you are one of those people who are busy in the month of September” Yes friends the association between a CA and tax audit is inseparable.

Purpose of Tax Audit:

The purpose of Tax Audit is to ensure that books of Accounts have been maintained in accordance with the provisions of the Income Tax Act. Circular No.387 issued by the Central Board of Direct Taxes which has been annexed to the material circulated to you also highlights this fact. Accordingly a proper audit for tax purposes would ensure that proper records are being maintained, and that the accounts properly reflect the income reported by the Assessee. This audit effectively curbs Tax Evasion and ensures Tax Compliance. Tax Audit also ensures that the Accounts are properly being presented to the Assessing Officers when called for. The precious time of the Assessing Officers is also saved from the routine and ineffective verifications like checking of totals and vouching of Purchase and Sales transactions. They can devote their time in more important investigation aspects of a Case. Thus Tax Audit saves considerable time to the Income Tax Department.

Who has to get accounts audited?

Now after knowing the purpose and necessity of Tax Audit, the next question arises as to the applicability of Tax Audit. Audit under section 44AB is applicable to four categories of Assesseess. Now let me explain each category one by one.

The first category covers any person carrying on a business whose total sales, turnover or gross receipts exceed Rupees Sixty Lakhs during the previous year. Here we should be careful about each word I said. Though the words Total Sales, Turnover and Gross Receipts seem to give the same meaning, each one has its own meaning. Various Legal forums have interpreted these words to have different meaning. The limit for this category was increased from Rs.40 lakhs to Rs.60 lakhs only by Finance Act, 2010 but with effect from 01.04.2011. Hence for the current Assessment Year the old limit of Rs.40 lakhs holds good.

The Second Category covers any person who is carrying on a profession whose gross receipts exceed Rs.15 lakhs. This limit also was increased from Rs.10 lakhs to Rs.15 lakhs by Finance Act, 2010 with effect from 01.04.2011.

The Third Category covers persons whose income is assessed on a presumptive basis under section 44AE, 44BB or 44BBB. Where such assessee declare an income lesser than that presumed under the Sections 44AE, 44BB or 44BBB, they are required get their accounts audited in accordance with Section 44AB.

The Fourth Category is of recent origin. It was brought into the act by virtue of Finance (No. 2) Act, 2009, with effect from 01.04.2011. This category covers those persons who declare a lower income than the amount presumed under section 44AD. The difference between the fourth and the third category is that, in the case of the fourth category, the assessees are subject to audit under section 44AB only if their income exceeds the basic exemption limit.

At this juncture it is worth quoting the amendments brought to Section 44AF and 44AD by Finance (No.2) Act, 2009. The said Act has now merged Section 44AF and Section 44AD of the Income Tax Act. The benefit of presumptive income under section 44AD and 44AF is now not restricted to civil contractions contracts and Retail Trade alone. Now any individuals and partnership firm excluding an LLP whose turnover does not exceed Rs.60 lakhs can avail this benefit. They just have to declare an income of 8% of gross turnover or a higher amount as income.

Any person who is covered by the above four categories is required to get his accounts audited by an accountant before 30th September each year. Now certain issues arise regarding the applicability of tax audit on account of a combination of the above four categories. ICAI has clarified quite a few of these issues through its Guidance Note on Tax Audit under Section 44AB of the Income Tax Act.

A question may arise as to the limit applicable if the assessee carries on both business and profession. For e.g. when a person has a business which has a turnover of say 61 lakhs and a professions whose gross receipt is just 9 lakhs, a question may arise as to whether the accounts of the profession are also subject to audit. ICAI has clarified the issue saying that both the business and profession are subject to audit though the gross receipts of the profession do not exceed Rs.15 lakhs. However if the business turnover is Rs.50 lakhs and professional receipts are Rs.10 lakhs, tax audit will not be applicable.

Where a person has more than one business, then in calculating the turnover for Section 44AB, the total turnover of all the business put together should be taken. It should also be noted that for calculating the turnover any turnover of business covered under presumptive income sections like Section 44B or 44BB or 44BBA or 44BBB or 44AD or 44AE should be excluded.

Let’s consider another situation. A firm has achieved a total gross turnover of Rs.65 lakhs. Sales return during the year amounts to Rs.10 lakhs. Out of the Sales Return of Rs.10 Lakhs Rs.4 lakhs belongs to the current year and Rs. 6 lakhs are returns of previous year. Now again the question arises as to the applicability of tax audit. If the total sales return is deducted, then the firm will not be subject to tax audit. ICAI through its guidance note has clarified that for the purpose of Section 44AB, sales return should be deducted from total turnover and that no distinction needs to be made as to the current year sales return and previous year sales return. Hence the firm will not be subject to Tax Audit

Let me give you another example. A firm has a total turnover 59 lakhs. During the year the firm had sold a car which was held for business use for Rs.2.5 lakhs. On adding up the two, the turnover becomes Rs.61.5 lakhs. Will tax audit be applicable in this situation? Here again ICAI has clarified that turnover will not include any amount received on account of sale of Fixed asset. Since it was originally held for business use, Tax audit will not be applicable.

Who can carry out Tax Audit?

After the applicability of Tax Audit, the next question arises regarding who can conduct Tax Audit. Section 44AB requires that the accounts should be audited by an Accountant. The explanation to Section 44AB states that the word accountant shall have the same meaning as the explanation to Section 288(2). The Explanation to Section 288(2) states that

“accountant” means a chartered accountant within the meaning of the Chartered Accountants Act, 1949 (38 of 1949), and includes, in relation to any State, any person who by virtue of the provisions of sub-section (2) of section 226of the Companies Act, 1956 (1 of 1956), is entitled to be appointed to act as an auditor of companies registered in that State.

Section 226 of the Companies Act, 1956 says that a person holding a certificate issued by a Part B State may also be appointed as an auditor. But this provision has no relevance today. No person is eligible to be appointed as an auditor by virtue of this provision today. Hence effectively only a Chartered Accountant holding a valid Certificate of Practice can carry out Tax Audit under section 44AB. This proves the level of trust we has been entrusted with. It will be in the duty of us all future Chartered Accountants to uphold this trust. After all C and A are the Alphabets of trust.

This monopolist trust vested on Chartered Accountants was also upheld by the Supreme Court in the Case of T.D. Venkata Rao v. Union of India [1999] 237 ITR 315 (SC).In this instant case, T.D.Venkata Rao, an Income Tax Practitioner, had questioned the legal validity of allowing only CAs to Audit under section 44AB. Supreme Court upheld the superiority of CAs by noting that Chartered Accountants, by reason of their training have special aptitude in the matter of audits and no other person can be held eligible to conduct audit under Section 44AB. Supreme Court further held that CAs are a Class by themselves meaning that CAs are the brand for auditing itself.

Exception to Tax Audit:

Once a person gets covered under any one of the four categories, Tax audit becomes mandatory. But there are two exceptions to tax audit. The first proviso to Section 44AB, exempts business covered under Section 44B and 44BBA from the purview of tax audit. But the second proviso is something more interesting. The second proviso says that if the accounts of a person are to be audited under any other law, it would be sufficient if the accounts are audited under that law before the 30th of September. The accounts need not once again be audited by an Accountant but the report in form 3CA and 3CD needs to be obtained from an Accountant.

The effects of this section arouse much fascination. Since Companies are required to be audited under the Companies Act, 1956, they need not be audited once again under Section 44AB. It is sufficient if the audit reports in the prescribed forms are obtained. This is even more fascinating in the Case of Co-operative Societies. Co-ops are required to be audited under the Co-operative Societies Act, but the auditor of a co-op need not be a CA. Even then a co-op need not be once again audited under Section 44AB.

Consequences if Companies follows different Accounting Year other than Financial Year:

Another Fascinating situation arises out of this proviso. Everyone is aware that under the income tax act, previous year means the financial year beginning from 1st April. But there is no such restriction under the Companies Act. Hence Companies may adopt the calendar year i.e. January to December as their Accounting Year. In such a situation a question arises where by using the above proviso, a Tax Auditor issue Form 3CA and Form 3CD for the previous year without auditing the accounts.

The CBDT clarified this issue vide Circular no.561 dated 22/05/1990. CBDT said that the second proviso is applicable only when the accounting year is same as the previous year. If the accounting year is different from the previous year then fresh audit has to be conducted. In this case, even though, the company was subject to statutory audit, the Tax auditor has to issue his report only in form 3CB and not in 3CA. Isn’t it fascinating?

Mode of Furnishing of Tax Audit Reports:

As per the age old practice, the assessees were required to get the Tax Audit Reports in the prescribed forms from an Accountant and file the same by the prescribed due date along with their return of Income. But with the advent of e-filing and ITR series of return forms, the situation has changed completely. As per the ITR philosophy, Returns are annexure less. No annexure like the computation sheet, Audited Financial Statements and Audit reports needs to be annexed.

As per the current scheme, the assessee has to obtain the tax audit report from the Tax auditor before 30th September and using the details given in it, prepare the applicable ITR form and file it either manually or electronically with the Income Tax Department. The Audit Reports are to be furnished only on the request of the Assessing Officer. But this scheme has many defects. There is no way to ascertain whether the accounts have been really audited or not. CBDT should consider a scheme of e-filing of Tax audit forms directly by the Tax auditor using his digital signature to remove this difficulty.

Penalty for failure to get accounts audited:

Non compliance of any provision of the Income Tax Act attracts huge penalty. Similarly the non compliance of Section 44AB attracts penalty under section 271B of the Income Tax Act, 1961. If any person who is required to get his accounts audited by an Accountant before the specified date fails to do so shall be liable for penalty under section 271B. The amount of penalty shall be half a percent of turnover / gross receipts or Rs.150000/- whichever is lower. The maximum penalty under this section was increased from one lakh to one and a half lakhs by the Finance Act, 2010, with effect from 01.04.2011. This penalty shows the seriousness that the Government affixes towards Tax Audit under section 44AB.

However no penalty may be levied if here is a reasonable cause for such failure. For e.g. in a firm it may so happen that the partner who manages the entire accounting and finance is not in the country and has gone abroad. In such a situation, the other partners will not be in a position to offer explanations to the Tax Auditor to complete his audit. Hence the accounts may not get audited by the due date. A similar situation also arises when the accountant quits the firm just before the end of September. But what serves as a reasonable cause is always uncertain.

Limitation on No of Tax Audits

In order to ensure quality and equitable distribution of audit work done by Chartered Accountants, ICAI has fixed a maximum limit for the Tax audit assignments that can be taken by a CA or a firm of CAs. This limit is set at 45 assignments per person. For if a firm of CAs has 3 partners, the maximum number of Tax audits that can be taken up by the firm will be 45*3 i.e. 135. If the firm takes all the 135, partners cannot take any audit in their personal capacity. If a person is found to have accepted more than 45 assignments in a year, he would be deemed to have been involved in professional misconduct.

1) Whether an assessee or a TRP or a Tax Consultant can prepare ITR4 for this A.Y 2013-14, if…
Assessee is an individual or HUF, having…
a) Total business turnover less than 1 Crore,
b) Maintains his books of accounts regularly.
c) Profits & gains from the business are not more than 8% of his total turnover.
d) Net profit from the business is bellow basic maximum income tax exemption limit, i.e., Rs 2 Lakh and
e) Agricultural Income is more than Rs 5 lakhs.

2) Whether an assessee or a Tax Consultant can prepare ITR5 for this A.Y 2013-14, if…
Assessee is a partnership firm, having…
a) Total business turnover less than 1 Crore,
b) Maintains his books of accounts regularly.
c) Profits & gains from the business are not more than 8% of his total turnover.
d) Net profit from the business is bellow basic maximum income tax exemption limit, i.e., Rs 0 and
e) Agricultural Income is more than Rs 5 lakhs.

The income tax act says under section 44AB as follows…
54[Audit of accounts of certain persons carrying on business or profession.
5544AB. 56Every person,—
66[(d) carrying on the business shall, if the profits and gains from the business are deemed to be the profits and gains of such person under section 44AD and he has claimed such income to be lower than the profits and gains so deemed to be the profits and gains of his business and his income exceeds the maximum amount which is not chargeable to income-tax in any previous year,]
get his accounts of such previous year 67[***] audited by an accountant before the specified date and 68[furnish by] that date the report of such audit in the prescribed form duly signed and verified by such accountant and setting forth such particulars as may be prescribed :
So…

I EXPECT YOUR VALUABLE GUIDANCE for the above instances, because if audit is not necessary the due date to file is 31st July 2013. Agricultural Income is an exempt income under section 10 and does not participate while calculating total income of an assessee as per the IT Act and it will be ONLY considered while calculating the tax on total income.

Hello Sir,
Very nice and helpful article for tax audit. Can you help me out , what will be the limit for tax audit under section 44 ab of company operating totally through website and is providing services not any product. Please explain your answer with any reference.

Hats off, the opening line of your article is very interesting. I have read many articles on tax audit but got to know from your article that India is the only country with
Tax audits done by Chartered Accountants.

An individual is a full time employee of a company. But after attaining the retirement age the company has recruited him as a full time consultant. He has been paid Rs. 42 Lakhs during the year, and TDS has been deducted u/s 194J.

The point to be observed in the above situation is that the assessee is neither carrying any other professional service and nor have any expenditure with respect to the above income, as he is employed as a full time consultant in the company.

a firm originally filed its return of income with turnover below the tax audit limit. later a survey was conducted on its premises and some additional turnover was found. the firm revised the financial statements and offered additional income on the extra turnover found. The turnover of the firm including the additional turnover found in survey exceeded the tax audit limit. The survey was conducted after due date for furnishing the tax audit report. hence no tax audit could be done and tax audit report could be filed. Whether the assessee firm is in default and is liable for penalty u/s 271B.